Change is the Only Constant: A Perspective on Changes to Canadian Income Tax Rules for Private Corporations

On July 18, 2017, the Federal Government announced changes to close "loopholes" in the taxation of private corporation income. One of the stated goals is to provide for "fairness" in the taxation of income so that business income earned through a private corporation is not "unfairly" subject to lesser rates of tax than other income. The purpose of this blog is not to discuss whether this should be a goal of our tax system. Change is a constant in all things, including tax policy, and a change in tax policy appears to be here, whether popular or not.

The July 18, 2017 tax proposals for private corporations were aimed at:

dividend income sprinkling and the multiplication of the lifetime capital gains exemptions;

converting dividend income into capital gains to get a lower tax rate; and,

passive investment income.

In mid-October, 2017, the Government announced it was not moving forward with the lifetime capital gains exemption multiplication or the conversion of dividend income to capital gains measures. As a result, they will also not be moving ahead with restrictions on "pipeline" planning, a strategy employed for private corporations in some instances as a post-mortem tax planning measure to avoid double-taxation on death where there is a gain in the value of the shares of the corporation held by a deceased person. It is, however, moving ahead with the dividend income sprinkling measures, and on December 13, 2017 released draft revised legislation for this purpose. It is also moving ahead with passive investment income measures, although draft legislation has not yet been released.

The draft legislation regarding income sprinkling of dividends from private corporations is complex. Expert advice should be obtained by anyone who thinks they may be affected by the changes. As a general summary, the new rules disallow the sprinkling of income from a private corporation to relatives who are "specified individuals". Unless an exemption applies, dividends falling within the definition of "split income" and which are paid to those who fall within the definition of "specified individual" will be taxed at the top marginal tax rate.

Expanded definitions of "specified individual" and "split income" have been included. There are special rules for inherited property designed to allow the beneficiary to be taxed in the same manner as the deceased. Exemptions under the new rules from taxation at the top marginal tax rate include for those who are over 18 and contribute to the business within the new definitions, or if the corporation does not derive at least 90% of its income from providing services, and the individual receiving dividend income owns more than 10% of the corporation, to specify just two new rules. Changes to an ownership structure should take place in 2018 under the new rules to bring individuals over the 10% threshold if desired. Other exemptions apply as well, some of them complex and technical. If passed, the rules apply from January 1, 2018.

While there has been no legislation released regarding the passive investment income measures, the Government has attempted to reassure private corporation shareholders by stating that active business income will be excluded from the new measures, there will be exclusions for savings intended as future business capital and grandfathering for existing passive investments, as well as a $50,000 threshold before the new tax rules apply. Incentives will be developed to ensure venture capital and angel investors continue to invest in private corporations. Whether shareholders are reassured by these statements from the Government is open to question.

Tax policies change constantly, and tax rules change with it. In 2015, the Federal Government (under a different majority party) made drastic changes to the long-standing rules regarding the taxation of testamentary trusts, with little warning or input from stakeholders. Historically, governments have made major policy shifts and revamped tax rules, fundamentally changing tax planning by Canadians.

As with any change, individual planning must change with it, and expert advice should be sought to determine what to do about the new tax rules. If a balanced and holistic approach is to be achieved, estate planning, while sometimes motivated by taxation, should never be wholly shaped by it. Ultimately, it is our personal objectives and wishes that should govern the bigger picture. Bearing that in mind should help us ride out the inevitable tax changes that will occur, and allow our most deeply-held goals to prevail.

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The July 18, 2017 tax proposals for private corporations were aimed at:

dividend income sprinkling and the multiplication of the lifetime capital gains exemptions;

converting dividend income into capital gains to get a lower tax rate; and,

passive investment income.

In mid-October, 2017, the Government announced it was not moving forward with the lifetime capital gains exemption multiplication or the conversion of dividend income to capital gains measures. As a result, they will also not be moving ahead with restrictions on "pipeline" planning, a strategy employed for private corporations in some instances as a post-mortem tax planning measure to avoid double-taxation on death where there is a gain in the value of the shares of the corporation held by a deceased person. It is, however, moving ahead with the dividend income sprinkling measures, and on December 13, 2017 released draft revised legislation for this purpose. It is also moving ahead with passive investment income measures, although draft legislation has not yet been released.

The draft legislation regarding income sprinkling of dividends from private corporations is complex. Expert advice should be obtained by anyone who thinks they may be affected by the changes. As a general summary, the new rules disallow the sprinkling of income from a private corporation to relatives who are "specified individuals". Unless an exemption applies, dividends falling within the definition of "split income" and which are paid to those who fall within the definition of "specified individual" will be taxed at the top marginal tax rate.

Expanded definitions of "specified individual" and "split income" have been included. There are special rules for inherited property designed to allow the beneficiary to be taxed in the same manner as the deceased. Exemptions under the new rules from taxation at the top marginal tax rate include for those who are over 18 and contribute to the business within the new definitions, or if the corporation does not derive at least 90% of its income from providing services, and the individual receiving dividend income owns more than 10% of the corporation, to specify just two new rules. Changes to an ownership structure should take place in 2018 under the new rules to bring individuals over the 10% threshold if desired. Other exemptions apply as well, some of them complex and technical. If passed, the rules apply from January 1, 2018.

While there has been no legislation released regarding the passive investment income measures, the Government has attempted to reassure private corporation shareholders by stating that active business income will be excluded from the new measures, there will be exclusions for savings intended as future business capital and grandfathering for existing passive investments, as well as a $50,000 threshold before the new tax rules apply. Incentives will be developed to ensure venture capital and angel investors continue to invest in private corporations. Whether shareholders are reassured by these statements from the Government is open to question.

Tax policies change constantly, and tax rules change with it. In 2015, the Federal Government (under a different majority party) made drastic changes to the long-standing rules regarding the taxation of testamentary trusts, with little warning or input from stakeholders. Historically, governments have made major policy shifts and revamped tax rules, fundamentally changing tax planning by Canadians.

As with any change, individual planning must change with it, and expert advice should be sought to determine what to do about the new tax rules. If a balanced and holistic approach is to be achieved, estate planning, while sometimes motivated by taxation, should never be wholly shaped by it. Ultimately, it is our personal objectives and wishes that should govern the bigger picture. Bearing that in mind should help us ride out the inevitable tax changes that will occur, and allow our most deeply-held goals to prevail.

-Susannah Roth

The comments offered in this article are meant to be general in nature, are limited to the law of Ontario, Canada, and are not intended to provide legal or tax advice on any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate to your personal circumstances.

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